BMO Financial Group - Outlook 2005(1.1Mb pdf File) - Boardwalk REIT

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32 an implied global stock-build of close to 300 million barrels in 2004. If OPEC were to continue to produce at its current rate through <strong>2005</strong>, global inventories would likely rise by a further 400 million barrels next year. Thus, while global demand has indeed risen sharply, global production has risen sufficiently to meet that demand and refill commercial inventories to more acceptable levels and permit a significant accumulation in national strategic petroleum reserves. US inventories of crude oil and products recover In the United States, prior to the substantial damage to Gulf of Mexico production inflicted by Hurricane Ivan, commercial inventories of crude oil had almost fought their way back to their five-year average, after showing deficits of close to 15% late last year and in early 2004. Similarly, gasoline inventories had been posting new five-year highs and distillates had been closely marking their five-year averages. In part, the recovery in inventories had reflected strong growth in imports of crude oil and products. During the late-August to October interval, however, production and import interruptions caused by hurricanes widened the deficit in crude oil inventories to about 6% and pushed gasoline and distillates into deficits, relative to five-year averages, of 1%, and 4%, respectively. With repairs to oil production and transportation infrastructure taking longer than expected and leading to even tighter markets, prices have risen abruptly. As Gulf production and transportation infrastructure is brought back to normal, commercial inventories of crude oil and those of products should recover to more normal levels, easing some pressure on prices. US strategic reserves nearly full Commercial inventories would have grown even more if the US government had not been such a strong competitor on the consumption side, in the rebuilding of its strategic petroleum reserve. Prior to the September 11th terrorist attack, the US Strategic Petroleum Reserve had been allowed to decline. For instance, between 1997 and 2001, it fell at an average annual pace of 1.4%. Following September 11, US policy shifted to an aggressive accumulation of its strategic reserve, which climbed 5.7% in 2002, 6.5% in 2003, and 8.5% year-to-date in 2004. The US strategic reserve now stands at about 670 million barrels and the government intends to continue its rapid accumulation until the reserve is filled to its 730 million barrel capacity. At the current pace of accumulation – about 1 million barrels per week – the strategic reserve would be full by next May. At that time, more oil will become available for commercial use. US government policy is to release petroleum from its strategic reserve only if there are market discontinuities, such as major disruptions of supply that might arise, for instance, from rebel insurgency in Nigeria. Tight margins of spare capacity contributing to higher oil prices Historically, when commercial inventories have matched their five-year average, the real price of WTI has tended to be close to US$25/barrel (in constant 2004 dollars), with a few notable exceptions, as discussed above. The current supply/demand and inventory situation would be consistent with a price for WTI of about US$30/barrel. This would consist of the long-term average of US$25 and a further $5 due to tightness in crude inventories. The much higher level of current prices reflects very narrow margins of OPEC excess capacity and sharply increased risks to supply. Historically, OPEC has had a much larger margin of excess capacity to meet unexpected developments. Spare capacity averaged 5 mmb/d in the 1999-2002 period. It slid to 3.2 mmb/d in 2003 and is currently near 1.5 mmb/d (about the same as Iraq exports on a good day and less than daily Yukos production). As a per
33 This year's surge in oil prices largely reflects... Real WTI Oil Price US$/bbl in constant 2004 dollars 100 80 60 40 20 0 1972:Q1 ...narrowing capacity restraints and supply risks... OPEC Spare Oil Production Capacity % of global demand 20 15 10 5 0 ...though market responses should reduce oil prices. WTI Oil Price US$/bbl 50 1985 1976:Q1 1987 1980:Q1 1989 1991 1984:Q1 1993 1988:Q1 1995 1992:Q1 Normal Range, Average=$25/bbl 1997 1996:Q1 1999 2000:Q1 2001 2003 2004:Q1 FORECAST cent of global oil consumption, excess capacity now measures less than 2%, well below the 6.6% average during 1999-2002. The sharp decline in excess capacity would argue for a higher price for oil (as it would for any commodity or product/ service). The last time excess capacity was as low as it currently is was in 1992, in the aftermath of the first Gulf War. When excess capacity recovered quickly in 1993, the average price of real WTI fell about US$4/barrel (in the absence of a noticeable change in the position of inventories during that period). It could be argued that a similar decline in the margin of spare capacity in 2004 would result in an even larger increase in price, given expectations that it will be more difficult to build capacity now than it was to rebuild capacity in the early 1990s. The current capacity squeeze could be placing upward pressure on prices in the neighbourhood of US$5/ barrel. Thus, even in the absence of elevated supply risks, market conditions would be consistent with a price of WTI of $35/barrel (the ‘normal’ price of $25/ barrel plus $5/barrel to reflect belowaverage crude inventories, and a further $5/barrel due to tight capacity margins). 40 30 20 10 1998:Q1 1999:Q1 2000:Q1 2001:Q1 2002:Q1 2003:Q1 2004:Q1 <strong>2005</strong>:Q1 2006:Q1 Supply risks are behind high oil prices In addition to the fact that excess capacity has significantly declined, there is now a much higher likelihood that excess capacity will be required. During the past year, the risk of terrorist strikes against oil infrastructure in the Middle East has not only risen abruptly, there have actually been several incidents. Additionally, social and political unrest in Venezuela and Nigeria have raised the potential for lost oil exports from those countries. The ongoing Yukos affair in
Page 3 and 4: OUTLOOK 2005 United States Outlook
Page 5 and 6: 3 United States Outlook Economy gai
Page 7 and 8: 5 Rising interest rates... 10-year
Page 9 and 10: 7 Tame inflation will allow the Fed
Page 11 and 12: 9 Canada Outlook Canada hit by nume
Page 13 and 14: 11 In 2005, the high C$ will restra
Page 15 and 16: 13 Though rates will rise in both C
Page 17 and 18: 15 Canada’s Regional Outlook Afte
Page 19 and 20: 17 have been trending downward sinc
Page 21 and 22: 19 fees and fines. Despite rising t
Page 23 and 24: 21 non-residential investment, and
Page 25 and 26: 23 The mining and oil and gas secto
Page 27 and 28: 25 average, with growth of 3.1% in
Page 29 and 30: 27 While interest rates are still l
Page 31 and 32: 29 moderate to 6.7% next year after
Page 33: 31 Global oil supply outpacing dema

BMO Financial Group - Outlook 2005(1.1Mb pdf File) - Boardwalk REIT

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